IPO investments will filter down

Most people would agree that having a healthy climate for technology startups is a good thing. According to the OECD, small- and medium-sized enterprises account for 60 to 70 per cent of jobs in most developed economies, but more importantly they account for a disproportionately large share of new jobs being created.

However the stock market crash of 2001 meant that the capital markets essentially closed for technology companies, as investors woke up from the late-1990s party and remembered that company valuations were supposed to be about profits, a small detail they had forgotten in the bubble years.

This may sound like an abstract issue of high finance, but it is not. Technology companies need capital to grow, and the closure of the IPO market meant that venture capital firms largely turned off the funding taps, given that they could not expect to see an IPO exit for their investments, which left only trade sales as a route to their making a return.

Some venture capital firms redirected their efforts into things like renewable energy, leaving technology startups to seek finance from angel investors and old-fashioned bank loans.

The latter, never an easy thing for a startup, became problematic with the banking crash of 2008, which caused credit to dry up.

To compound things, large companies became more conservative in their buying practices after 2001, no longer willing to risk buying technology from a hot startup and falling back on tried-and-tested, if less innovative, software from the industry behemoths.

This all added up to a tough time for small tech firms, especially those in enterprise software.

However, investors seem to be recovering their nerve. The huge success of Google showed that, at least in its case, mindshare could translate into profits too.

In the last quarter of 2011 Google made profits of $3.5bn on revenues of $10.6bn, a handsome level of return by any standards.

In 2011 the outlook for technology had improved sufficiently that IPOs occurred for companies like LinkedIn, Groupon and Zynga, Valuations of companies are returning to dizzy levels.

Facebook’s IPO filingvalues it at $94bn, heady stuff for a company with $3.7bn of revenues of $1bn in profits (time will tell what the markets actually pay, of course).

Another interesting example is Instagram, a mobile phone app company with just a dozen employees and seemingly no revenue model as yet, whose latest funding round suggest a $500m valuation, while Twitter’s last funding round valued it at $8bn.

One thing that you will notice about these companies is that they are all in the consumer rather than the enterprise space. However, there are positives for enterprise software startups too.

The shift to the cloud licensing model means that companies can take advantage of cloud hosting providers rather than needing to build datacentres of their own.

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